Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [X] No [ ]

As of September 2, 2014, there were 21,614,941 shares of Hancock Fabrics, Inc. $.01 par value common stock outstanding.

2

Table of Contents

Hancock Fabrics, Inc.,

INDEX TO FORM 10-Q

Part I. Financial Information

Page

Item 1. Condensed Financial Statements (unaudited)

Consolidated Balance Sheets as of July 26, 2014, July 27, 2013, and January 25, 2014

4

Consolidated Statements of Operations and Comprehensive Loss for the Thirteen and Twenty-six Weeks Ended July 26, 2014 and July 27, 2013

(1) From consolidated audited balance sheet included in our annual report on Form 10-K for the fiscal year ended January 25, 2014.

4

HANCOCK FABRICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(unaudited)

Thirteen Weeks Ended

Twenty-six Weeks Ended

July 26,

July 27,

July 26,

July 27,

(in thousands, except per share amounts)

2014

2013

2014

2013

Net sales

$

59,317

$

59,134

$

122,311

$

122,875

Cost of goods sold

32,838

32,593

67,397

67,357

Gross profit

26,479

26,541

54,914

55,518

Selling, general and administrative expenses

27,369

26,911

53,929

53,710

Depreciation and amortization

989

887

1,949

1,776

Operating (loss) income

(1,879

)

(1,257

)

(964

)

32

Interest expense, net

1,442

1,369

2,808

3,125

Loss before income taxes

(3,321

)

(2,626

)

(3,772

)

(3,093

)

Income taxes

-

-

-

-

Net loss

$

(3,321

)

$

(2,626

)

$

(3,772

)

$

(3,093

)

Other comprehensive income

Minimum pension, SERP and OPEB liabilities, net of taxes $0

138

139

277

278

Comprehensive loss

$

(3,183

)

$

(2,487

)

$

(3,495

)

$

(2,815

)

Net loss per share, basic and diluted

$

(0.16

)

$

(0.13

)

$

(0.18

)

$

(0.15

)

Weighted average shares outstanding:

Basic and diluted

20,913

20,466

20,897

20,453

See accompanying notes to consolidated financial statements.

5

HANCOCK FABRICS, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)

(unaudited)

Accumulated

Other

Total

Additional

Comprehensive

Shareholders'

(in thousands,

Common Stock

Paid-in

Retained

Treasury Stock

Income

Equity

except for number of shares)

Shares

Amount

Capital

Earnings

Shares

Amount

(Loss)

(Deficit)

Balance January 25, 2014

35,116,436

$

351

$

91,360

$

94,484

(13,475,432

)

$

(153,793

)

$

(29,320

)

$

3,082

Net loss

(3,772

)

(3,772

)

Minimum pension, SERP and OPEB liabilities, net of taxes of $0

277

277

Issuance of restricted stock

12,000

-

Cancellation of restricted stock

(105,162

)

(1

)

1

-

Vesting of restricted stock units

11,574

Stock-based compensation

345

345

Purchase of treasury stock

(2,875

)

(3

)

(3

)

Balance July 26, 2014

35,034,848

$

350

$

91,706

$

90,712

(13,478,307

)

$

(153,796

)

$

(29,043

)

$

(71

)

See accompanying notes to consolidated financial statements.

6

HANCOCK FABRICS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

Twenty-six Weeks Ended

July 26,

July 27,

(in thousands)

2014

2013

Cash flows from operating activities:

Net loss

$

(3,772

)

$

(3,093

)

Adjustments to reconcile net loss to cash flows used in operating activities

Depreciation and amortization, including cost of goods sold

2,365

2,389

Amortization of deferred loan costs

356

361

Amortization of discount on notes

-

379

Stock-based compensation

345

276

Inventory valuation reserve

124

576

Other

103

114

Change in assets and liabilities:

Receivables and prepaid expenses

829

(226

)

Inventories

(6,822

)

(7,684

)

Other assets

52

(534

)

Accounts payable

223

4,656

Accrued liabilities

(685

)

(484

)

Postretirement benefits other than pensions

(311

)

(562

)

Pension and SERP liabilities

(1,434

)

(1,350

)

Other liabilities

99

(126

)

Net cash used in operating activities

(8,528

)

(5,308

)

Cash flows from investing activities:

Purchase of property and equipment

(2,437

)

(1,803

)

Proceeds from the disposition of property and equipment

86

13

Net cash used in investing activities

(2,351

)

(1,790

)

Cash flows from financing activities:

Net borrowings on revolving credit facility

11,535

5,288

Other

(89

)

(89

)

Net cash provided by financing activities

11,446

5,199

Increase (decrease) in cash and cash equivalents

567

(1,899

)

Cash and cash equivalents:

Beginning of period

1,806

4,062

End of period

$

2,373

$

2,163

Supplemental disclosures:

Cash paid during the period for:

Interest

$

2,661

$

2,770

Contributions to the defined benefit pension plan

$

2,350

$

2,350

Income taxes

-

-

Non-cash activities:

Noncash change in funded status of benefit plans

277

278

See accompanying notes to consolidated financial statements.

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

NOTE 1 –BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

Hancock Fabrics, Inc. is a specialty retailer committed to nurturing creativity through a complete selection of fashion and home decorating textiles, crafts, sewing accessories, needlecraft supplies and sewing machines. As of July 26, 2014, Hancock operated 260 stores in 37 states and an internet store under the domain name hancockfabrics.com. Hancock conducts business in one operating business segment.

References herein to “Hancock,” the “Company,” “Registrant,” “we,” “our” or “us” refer to Hancock Fabrics, Inc. and its subsidiaries unless the context specifically indicates otherwise. References herein to second quarter 2014 and second quarter 2013 are for the 13 week periods ended July 26, 2014 and July 27, 2013, respectively. References to twenty-six weeks 2014, first half 2014 or 2014, and twenty-six weeks 2013, first half 2013 or 2013 are for the 26 week periods ended July 26, 2014 and July 27, 2013, respectively.

Basis of Presentation

We maintain our financial records on a 52-53 week fiscal year ending on the last Saturday in January with each new fiscal year commencing on the Sunday thereafter. All quarters consist of 13 weeks except for one 14 week period in 53 week years.

The accompanying unaudited Consolidated Financial Statements should be read in conjunction with our audited Consolidated Financial Statements and accompanying notes in our Annual Report on Form 10-K for the year ended January 25, 2014 filed with the U.S. Securities and Exchange Commission (“SEC”) on April 25, 2014. The accompanying (a) consolidated balance sheet as of January 25, 2014, has been derived from audited financial statements, and (b) the unaudited consolidated interim financial statements have been prepared pursuant to SEC Rule 10-01 of Regulation S-X. Accordingly, certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted pursuant to those rules and regulations from the interim financial statements, although we believe that the disclosures made are adequate to make the information not misleading.

The unaudited results of operations for the interim periods shown in these financial statements are not necessarily indicative of operating results for the entire year. In the opinion of management, the accompanying unaudited Consolidated Financial Statements recognize all adjustments of a normal recurring nature considered necessary to fairly state our consolidated financial position as of July 26, 2014 and July 27, 2013, and our consolidated results of operations and cash flows for the twenty-six weeks ended July 26, 2014, and July 27, 2013.

The unaudited Consolidated Financial Statements have been prepared in accordance with GAAP applicable to a going concern. Except as otherwise disclosed, these principles assume that assets will be realized and liabilities will be discharged in the ordinary course of business.

8

NOTE 2 –EMPLOYEE BENEFIT PLANS

Retirement Plans. The following summarizes the net periodic benefit cost for Hancock’s defined benefit pension retirement plan and its postretirement health care benefit plan for the thirteen and twenty-six weeks ended July 26, 2014 and July 27, 2013 (in thousands):

Retirement Plan

Postretirement

Benefit Plan

Retirement Plan

Postretirement

Benefit Plan

Thirteen Weeks Ended

Twenty-six Weeks Ended

July 26,

July 27,

July 26,

July 27,

July 26,

July 27,

July 26,

July 27,

2014

2013

2014

2013

2014

2013

2014

2013

Service costs

$

149

$

153

$

13

$

17

$

298

$

306

$

26

$

35

Interest cost

1,022

1,009

33

28

2,044

2,017

66

56

Expected return on assets

(1,033

)

(1,010

)

-

-

(2,066

)

(2,020

)

0

-

Amortization of prior service costs

-

-

(167

)

(181

)

0

-

(334

)

(361

)

Recognized net actuarial (gain) loss

339

367

(33

)

(47

)

678

734

(66

)

(95

)

Net periodic benefit cost (gain)

$

477

$

519

$

(154

)

$

(183

)

$

954

$

1,037

$

(308

)

$

(365

)

At July 26, 2014, the fair value of the assets held by the pension plan was $65.1 million reflecting a $1.1 million increase from January 25, 2014. Cash contributions to the pension plan of $2.4 million during the twenty-six weeks ended July 26, 2014 are included in that increase. Service costs consist of administrative expenses paid out of the pension trust.

NOTE 3 –EARNINGS (LOSS) PER SHARE

Earnings (loss) per share is presented for basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to holders of common stock by the weighted-average number of common shares outstanding for the period. Diluted earnings (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings (loss) of the Company.

As of July 26, 2014, there were outstanding warrants for 9,838,000 shares with an exercise price of $0.59, which will expire on November 20, 2019. In addition, there were stock options for 1,515,324 shares with a weighted average exercise price of $0.91, and approximately 818,700 restricted stock units and restricted shares. Each of these would be included in the computation as common stock equivalents for diluted earnings (loss) per share, if the impact was not anti-dilutive.

9

COMPUTATION OF LOSS PER SHARE

(in thousands, except for share and

Thirteen Weeks Ended

Twenty-six Weeks Ended

per share amounts)

July 26,

July 27,

July 26,

July 27,

2014

2013

2014

2013

Basic and diluted loss per share:

Net loss

$

(3,321

)

$

(2,626

)

$

(3,772

)

$

(3,093

)

Weighted average number of common shares outstanding during period

20,913,086

20,466,236

20,896,960

20,452,890

Basic and diluted loss per share

$

(0.16

)

$

(0.13

)

$

(0.18

)

$

(0.15

)

Using the Treasury Stock method, the number of shares excluded from the diluted loss per share calculation totaled approximately 12.2 and 15.3 million for the second quarters and 12.5 and 15.3 million for the twenty-six weeks of 2014 and 2013, respectively.

NOTE 4 – LONG-TERM DEBT OBLIGATIONS

On November 15, 2012, the Company entered into an amended and restated loan and security agreement with its direct and indirect subsidiaries, General Electric Capital Corporation, as working capital agent, GA Capital, LLC, as term loan agent, and the lenders party thereto, which expires on November 15, 2016. The amended and restated loan and security agreement amends and restates the Company’s loan and security agreement dated as of August 1, 2008, and provides senior secured financing of $115 million, consisting of (a) an up to $100 million revolving credit facility (the "Revolver"), which includes a letter of credit sub-facility of up to $20.0 million, and (b) an up to $15.0 million term loan facility (the "Term Loan"). The level of borrowings available is subject to a borrowing base computation, as defined in the amended and restated loan and security agreement, which includes credit card receivables, inventory, and real property. Principal amounts outstanding under both the Revolver and the Term Loan bear interest at a rate equal to, at the option of the borrowers, either (a) a London Interbank Offered Rate (“LIBOR”) determined by reference to the offered rate for deposits in dollars for the interest period relevant to such borrowing (the “Eurodollar Rate”), or (b) a prime rate, in each case plus an applicable margin and adjusted for certain additional costs and fees. The applicable margin for borrowings under the Revolver is 2.50% with respect to the Eurodollar Rate and 1.50% with respect to the prime rate loans and under the Term Loan is 10.0% with respect to the Eurodollar Rate and 9.0 % with respect to the prime rate loans.

The Revolver and Term Loan are collateralized by a fully perfected first priority security interest in all of the existing and after acquired real and personal tangible and intangible assets of the Company.

As of July 26, 2014, the Company had outstanding borrowings under the Revolver of $67.0 million and $15.0 million under the Term Loan, and amounts available to borrow of $10.5 million.

At July 26, 2014, Hancock had commitments under the above credit facility of $1.5 million, under documentary letters of credit, which support purchase orders for merchandise. Hancock also has standby letters of credit to guarantee payment of potential insurance claims and freight charges. These letters of credit amounted to $4.9 million as of July 26, 2014.

10

On November 20, 2012, the Company exchanged approximately $16.4 million aggregate principal amount of the Company’s outstanding $21.6 million of Floating Rate Series A Secured Notes (the “Existing Notes”) originally issued pursuant to an Indenture dated as of June 17, 2008 (the “2008 Indenture”) between the Company and Deutsche Bank National Trust Company (“DBNTC”), as trustee thereunder, for (a) the Company’s Floating Rate Series A Secured Notes Due 2017 in an aggregate principal amount of approximately $8.2 million (the “New Notes”) issued pursuant to an indenture dated as of November 20, 2012 between the Company and DBNTC, as trustee thereunder (the “New Indenture”), and (b) cash consideration in the aggregate amount of approximately $8.2 million. After completion of the exchange, approximately $5.1 million aggregate principal amount of Existing Notes remained outstanding.

On January 31, 2013, the Company retired the remaining $5.1 million of Existing Notes outstanding, with funds from the Revolver, and wrote off the related unamortized discount of $379,000.

The New Notes bear interest at a variable rate, adjusted quarterly, equal to a LIBOR rate plus 12% per annum until maturity on November 20, 2017. The New Notes and the related guarantees provided by certain subsidiaries of the Company are secured by a lien on substantially all of the Company’s and the subsidiary guarantors’ assets, in each case, subject to certain prior liens and other exceptions, but the New Notes are subordinated in right of payment in certain circumstances to all of the Company’s existing and future senior indebtedness, including the Company’s Amended and Restated Loan and Security Agreement, dated as of November 15, 2012.

As of July 26, 2014, the Company had an outstanding balance of $8.2 million on the New Notes.

NOTE 5– SUBSEQUENT EVENTS

On August 4, 2014, the Company announced that the Board of Directors had determined not to seek stockholder approval at the August 15, 2014 shareholders’ meeting for the reverse stock split transaction contemplated by the Company’s Schedule 14A filed with the SEC on July 8, 2014.

Management has evaluated subsequent events through the date of this Quarterly Report and is not aware of any additional subsequent events that required adjustment or disclosure in connection with the financial statements for the period ended July 26, 2014.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated financial statements as of and for the thirteen and twenty-six weeks ended July 26, 2014, including the notes to those statements, appearing elsewhere in this report. We also suggest that management’s discussion and analysis appearing in this report be read in conjunction with the management’s discussion and analysis and consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended January 25, 2014. Our fiscal year ends on the last Saturday in January and refers to the calendar year ended immediately prior to such date, which contained the substantial majority of the fiscal period (e.g., “fiscal 2013” or “2013” refers to the fiscal year ended January 25, 2014). Fiscal years consist of 52 weeks, comprised of four 13-week fiscal quarters, unless noted otherwise. References herein to second quarter 2014 and second quarter 2013 are for the 13 week periods ended July 26, 2014 and July 27, 2013, respectively. References to twenty-six weeks 2014, first half 2014 or 2014, and twenty-six weeks 2013, first half 2013 or 2013 are for the 26 week periods ended July 26, 2014 and July 27, 2013, respectively. References herein to “Hancock,” the “Company,” “Registrant,” “we,” “our,” or “us” refer to Hancock Fabrics, Inc. and its subsidiaries unless the context specifically indicates otherwise.

11

Forward Looking Statements

This Quarterly Report on Form 10-Q (“Quarterly Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). Such statements are not historical facts and reflect our current views regarding matters such as operations and financial performance. In general, forward-looking statements are identified by such words or phrases as “anticipates,” “believes,” “approximates,” “estimates,” “expects,” “intends” or “plans” or the negative of those words or other terminology. Forward-looking statements involve inherent risks and uncertainties; our actual results could differ materially from those expressed in our forward-looking statements.

The risks and uncertainties, either alone or in combination, that could cause our actual results to differ from those expressed in our forward-looking statements include, but are not limited to, the following: our business and operating results may be adversely affected by the general economic conditions and the ongoing slow economic recovery; intense competition and adverse discounting actions taken by competitors; our merchandising initiatives and marketing emphasis may not provide expected results; changes in customer demands and failure to manage inventory effectively could adversely affect our operating results; our inability to effectively implement our growth strategy and access funds for future growth may have an adverse effect on sales growth; our ability to attract and retain skilled people is important to our success; we have significant indebtedness and interest rate increases could negatively impact profitability; significant changes in discount rates, mortality rates, actual investment return on pension assets, changes in consumer demand or purchase patterns and other factors could affect our earnings, equity, and pension contributions in future periods; business matters encountered by our suppliers may adversely impact our ability to meet our customers’ needs; tightening of purchase terms by suppliers and their factories may have a negative impact on our business; we are vulnerable to risks associated with obtaining merchandise from foreign suppliers; transportation industry challenges and rising fuel costs may negatively impact our operating results; delays or interruptions in the flow of merchandise between our suppliers and/or our distribution center and our stores could adversely impact our operating results; changes in the labor market and in federal, state, or local regulations could have a negative impact on our business; taxing authorities could disagree with our tax treatment of certain deductions or transactions, resulting in unexpected tax assessments; our current cash resources might not be sufficient to meet our expected near-term cash needs; a disruption in our information systems would negatively impact our business; a failure to adequately maintain the security of confidential information could have an adverse effect on our business; failure to comply with various laws and regulations as well as litigation developments could adversely affect our business operations and financial performance; we may not be able to maintain or negotiate favorable lease terms for our retail stores; changes in accounting principles may have a negative impact on our reported results; our results may be adversely affected by serious disruptions or catastrophic events, including geo-political events and weather; changes in newspaper subscription rates may result in reduced exposure to our circular advertisement; unexpected or unfavorable consumer responses to our promotional or merchandising programs could materially adversely affect our sales, results of operations, cash flow and financial condition; and other risks and uncertainties that are discussed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on April 25, 2014 under Item 1A. Risk Factors. Forward-looking statements speak only as of the date made, and neither Hancock nor its management undertakes any obligation to update or revise any forward-looking statement.

Our Business

Hancock Fabrics, Inc. is a specialty retailer committed to nurturing creativity through a complete selection of fashion and home decorating textiles, sewing accessories, needlecraft supplies and sewing machines. We are one of the largest fabric retailers in the United States, operating as of July 26, 2014, 260 stores in 37 states and an internet store under the domain name hancockfabrics.com. Our stores present a broad selection of fabrics and notions used in apparel sewing, home decorating and quilting projects. None of the information on the website referenced above is incorporated by reference into our reports filed with, or furnished to, the SEC.

12

Overview

Financial Summary:

●

Sales for the second quarter of 2014 were $59.3 million compared to $59.1 million for the second quarter of 2013, and comparable store sales increased 0.9% in the second quarter of 2014 following a decrease of 1.7% in the second quarter of 2013. Sales for the first half of 2014 were $122.3 million compared to $122.9 million for the first half of 2013 and comparable store sales declined 0.1% following a decrease of 0.8% in the first half of 2013. Management believes severe winter weather in the first quarter negatively impacted the first half of 2014 by approximately $1.8 million.

●

Our online sales for the second quarter of 2014, which are included in the sales number and comparable sales percentage above, increased 6.6% to $0.9 million compared to $0.8 million for the second quarter of 2013 and increased by 4.5% to $1.8 million in the first half of 2014 compared to $1.7 million in the first half of 2013.

●

Gross profit for the second quarter and first half of 2014 was 44.6% and 44.9%, respectively, compared with 44.9% and 45.2% for the second quarter and first half of 2013, respectively.

●

Operating loss was $1.9 million for the second quarter of 2014 compared to a loss of $1.3 million in the second quarter of 2013. For the first half of 2014, operating loss was $1.0 million compared to operating income of $32 thousand for the first half of 2013.

●

Net loss was $3.3 million, or $0.16 per basic share, in the second quarter of 2014 compared to a net loss of $2.6 million, or $0.13 per basic share in the second quarter of 2013. Net loss was $3.8 million or $0.18 per basic share in the first half of 2014 compared to a net loss of $3.1 million or $0.15 per basic share in the first half of 2013.

●

The amount of cash used in operating activities was $8.5 million during the first half of 2014 compared to $5.3 million of cash used in operating activities for the first half of 2013.

13

We use a number of key performance measures to evaluate our financial performance, including the following:

Thirteen Weeks Ended

Twenty-six Weeks Ended

July 26,

July 27,

July 26,

July 27,

2014

2013

2014

2013

Net sales (in thousands)

$

59,317

$

59,134

$

122,311

$

122,875

Gross margin percentage

44.6

%

44.9

%

44.9

%

45.2

%

Number of stores (1)

Open at end of period

260

261

260

261

Comparable stores at period end (2)

257

259

257

259

Sales growth

All stores and e-commerce

0.3

%

(2.2

)%

(0.5

)%

(1.2

)%

Comparable stores and e-commerce

0.9

%

(1.7

)%

(0.1

)%

(0.8

)%

Total store square footage at period end (in thousands)

3,600

3,692

3,600

3,692

Net sales per total square footage

$

16.48

$

16.02

$

33.98

$

33.28

(1)

Store count does not include the internet store.

(2)

A new store is included in the comparable sales computation immediately upon reaching its one-year anniversary. In instances where stores are either expanded, down-sized or relocated within an existing market the store is not treated as a new store and, therefore, remains in the computation of comparable sales.

Results of Operations

The following table sets forth, for the periods indicated selected statement of operations data expressed as a percentage of sales. This table should be read in conjunction with the following discussion and with our Consolidated Financial Statements, including the related notes.

Thirteen Weeks Ended

Twenty-six Weeks Ended

July 26,

July 27,

July 26,

July 27,

2014

2013

2014

2013

Net sales

100.0

%

100.0

%

100.0

%

100.0

%

Cost of goods sold

55.4

55.1

55.1

54.8

Gross profit

44.6

44.9

44.9

45.2

Selling, general and administrative expense

46.1

45.5

44.1

43.7

Depreciation and amortization

1.7

1.5

1.6

1.5

Operating (loss) income

(3.2

)

(2.1

)

(0.8

)

-

Interest expense, net

2.4

2.3

2.3

2.5

Loss before income taxes

(5.6

)

(4.4

)

(3.1

)

(2.5

)

Income taxes

0.0

0.0

0.0

0.0

Net loss

(5.6

)%

(4.4

)%

(3.1

)%

(2.5

)%

14

Net Sales

Thirteen Weeks Ended

Twenty-six Weeks Ended

(in thousands)

July 26,

July 27,

July 26,

July 27,

2014

2013

2014

2013

Retail comparable store base

$

58,038

$

57,161

$

119,619

$

119,039

E-Commerce

883

828

1,812

1,734

Comparable sales

58,921

57,989

121,431

120,773

New stores

396

437

880

798

Closed stores

-

708

-

1,304

Total net sales

$

59,317

$

59,134

$

122,311

$

122,875

For 2014, the retail comparable store base above consists of the stores which were included in the comparable sales computation for the respective periods. For 2013, the retail comparable store base above excludes new stores for that period and stores that have closed subsequent to that period. The second quarter 2014 comparable sales (excluding e-commerce) increase of 0.8% was the result of a 2.7% improvement in average ticket evidencing higher sales volumes for each individual transaction partially offset by a 1.9% decrease in transaction count. The first half 2014 retail comparable sales decline of 0.3% resulted from a 3.3% decline in transaction count partially offset by a 3.0% increase in average ticket.

Sales provided by our e-commerce channel increased 6.6% and 4.5% in the second quarter and the twenty-six weeks of fiscal 2014, respectively, compared to the same periods in fiscal 2013. The sales improvement can be primarily attributed to the launch of the new website which occurred in the first quarter of 2014 and an increase in the number of SKUs offered.

Three new stores opened and four stores, where we chose not to stay in the market, have closed since the second quarter of 2013. The sales from these locations are included in total net sales. The Company did not relocate any stores during the second quarter of 2014 and ended the period with 260 stores.

Our merchandise mix has had minimal change year over year, as reflected in the table below.

The classification of these expenses varies across the retail industry.

Specific components of cost of goods sold for the second quarters and the twenty-six weeks of fiscal 2014 and 2013 are as follows:

Thirteen Weeks Ended

Twenty-six Weeks Ended

July 26,

% of

July 27,

% of

July 26,

% of

July 27,

% of

(dollars in thousands)

2014

Sales

2013

Sales

2014

Sales

2013

Sales

Total net sales

$

59,317

100.0

%

$

59,134

100.0

%

$

122,311

100.0

%

$

122,875

100.0

%

Merchandise cost

27,403

46.2

%

27,368

46.3

%

56,787

46.4

%

57,489

46.8

%

Freight

2,240

3.8

%

2,035

3.4

%

4,374

3.6

%

3,991

3.2

%

Sourcing and warehousing

3,195

5.4

%

3,190

5.4

%

6,236

5.1

%

5,877

4.8

%

Gross Profit

$

26,479

44.6

%

$

26,541

44.9

%

$

54,914

44.9

%

$

55,518

45.2

%

Merchandise cost declined as a percentage of sales for the second quarter of 2014 as compared to the same period of 2013 by 10 basis points. This decline occurred from a reduction in inventory shrink which offset increased merchandise costs. For the twenty-six weeks of 2014 compared to the twenty-six weeks of 2013, merchandise cost decreased by 40 basis points. The decline resulted from a reduction in shrink and inventory valuation results, which were partially offset by increased merchandise costs for the twenty-six week period.

Freight expense is 40 basis points higher as a percentage of sales for the second quarter and the twenty-six weeks of 2014 as compared to the same periods of 2013. This increase was driven by higher volumes of inbound freight to the Company’s distribution center and increased shipments to stores as compared to the prior year.

Sourcing and warehousing costs for the Company vary based on the volume of inventory received during any period, the rate at which inventory is shipped out, and inventory turns. The cost difference for the twenty-six weeks of 2014 compared to the same periods in 2013 is due to a one-time benefit in 2013 that resulted from a change in the method used to calculate inventory turns, which increased the amount of sourcing and warehousing costs capitalized in inventory.

In total, gross margin declined by 30 basis points in the second quarter 2014 from second quarter 2013 and the twenty-six weeks of 2014 as compared to the same period of 2013.

occupancy including rent, common area maintenance, taxes and insurance for our retail locations

●

operating costs of our headquarter facilities

●

other expense (income)

Specific components of selling, general and administrative expenses (SG&A) include:

Thirteen Weeks Ended

Twenty-six Weeks Ended

July 26,

% of

July 27,

% of

July 26,

% of

July 27,

% of

(dollars in thousands)

2014

Sales

2013

Sales

2014

Sales

2013

Sales

Retail store labor costs

$

9,838

16.6

%

$

9,376

15.9

%

$

19,333

15.8

%

$

19,072

15.5

%

Advertising

2,498

4.2

%

2,608

4.4

%

4,708

3.8

%

4,952

4.0

%

Store occupancy

7,376

12.4

%

7,506

12.7

%

14,998

12.3

%

15,015

12.2

%

Retail SG&A

4,876

8.2

%

4,859

8.2

%

9,292

7.6

%

9,365

7.7

%

Corp SG&A

2,781

4.7

%

2,562

4.3

%

5,598

4.6

%

5,306

4.3

%

Total SG&A

$

27,369

46.1

%

$

26,911

45.5

%

$

53,929

44.1

%

$

53,710

43.7

%

Retail Store Labor Costs – The Company store labor costs increased during the second quarter of 2014 as compared to the same period in 2013. The increase was primarily the result of increased benefit costs for medical claims as compared to 2013 and additional store payroll. For the twenty-six weeks of 2014, labor costs increased due to additional wages incurred at stores as compared to the same period of 2013.

Advertising – The reduction in advertising expense for the second quarter of 2014 and the twenty-six weeks of 2014 as compared to the same periods in 2013 were achieved by improvements to our marketing program which allows us to reach a larger audience with a smaller expenditure.

Store Occupancy – The Company’s store occupancy expense decreased slightly as compared to the same period of the prior year for both the second quarter and the twenty-six weeks of 2014. This was primarily due to reductions in maintenance and repair expense and were partially offset by increased occupancy related expenses.

Retail SG&A – Retail selling, general and administrative expenses for the second quarter and the twenty-six weeks of 2014 were basically flat as compared to the same periods of 2013. The net commission income from a third party loyalty program, which began in the fourth quarter of 2013, offset increased costs for insurance, travel and utilities.

Corporate SG&A – These are costs related primarily to staffing and operation of the Company’s headquarters. The increase for the second quarter of 2014 as compared to the second quarter of 2013 resulted from additional compensation related costs and professional fees, which were partially offset by reductions in employee relocation expenses. The variance for the twenty-six weeks of 2014 as compared to the same period of 2013 is due to increased compensation costs and professional fees, partially offset by reductions in employee travel and relocation costs.

17

Interest Expense

Thirteen Weeks Ended

Twenty-six Weeks Ended

(dollars in thousands)

July 26,

% of

July 27,

% of

July 26,

% of

July 27,

% of

2014

Sales

2013

Sales

2014

Sales

2013

Sales

Interest expense, net

$

1,442

2.4

%

$

1,369

2.3

%

$

2,808

2.3

%

$

3,125

2.5

%

The Company’s interest costs are driven by borrowings on our credit facilities and a small number of capital leases. We currently have an asset-based facility and subordinated-debt outstanding. Interest expense for the twenty-six weeks of 2013 includes $379,000 of non-cash expense for note discount amortization (see Note 4 to the Consolidated Financial Statements included in this report). Excluding the non-cash item, interest expense was $2.7 million or 2.2% of sales for the twenty-six weeks of 2013.

Income Taxes

The Company did not recognize any income tax benefit during the periods of fiscal 2014 or 2013 presented in this report given the uncertainty in realizing the future benefit. As of July 26, 2014, January 25, 2014, and July 27, 2013 the Company has established a 100% valuation allowance to offset the net deferred tax assets related to net operating loss carryforwards and other book-tax timing differences.

Liquidity and Capital Resources

Hancock's primary capital requirements are for the financing of inventories and, to a lesser extent, for capital expenditures relating to store locations and its distribution facility. Funds for such purposes have historically been generated from Hancock's operations, short-term trade credit in the form of extended payment terms from suppliers for inventory purchases, and long-term borrowings from commercial lenders.

Due to our history of losses over the past three fiscal years, we have not generated positive operating cash flow during such period. As a result, since fiscal 2011, we have increasingly relied on borrowings for our capital needs to fund the Company’s working capital needs, its required cash contribution to the Company’s defined benefit pension plan, for capital expenditures, and losses from operations. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation-Liquidity and Capital Resources” in our Annual Report on Form 10-K for the year ended January 25, 2014 filed with the SEC on April 25, 2014.

At July 26, 2014, the Company had outstanding long-term indebtedness of $90.2 million. As a consequence of our significant amount of indebtedness as of July 26, 2014, a significant portion of our cash flow from operations must be dedicated to interest and principal payments on our indebtedness, thereby reducing the availability of our cash flow to fund capital expenditures or other growth initiatives and other general corporate requirements, see “Item 1A. Risk Factors − Risks Related to Our Business − We have a significant amount of indebtedness, which could have important negative consequences to us” in our Annual Report on Form 10-K for the year ended January 25, 2014 filed with the SEC on April 25, 2014. In addition, at July 26, 2014, the Company had limited cash resources, with cash of $2.4 million, see “Item 1A. Risk Factors − Risks Related to Our Business − Our current cash resources might not be sufficient to meet our expected near-term cash needs” in our Annual Report on Form 10-K for the year ended January 25, 2014 filed with the SEC on April 25, 2014.

18

Our short-term and long-term liquidity needs arise primarily from our working capital requirements, required cash contributions to the defined benefit pension plan, planned capital expenditures and debt service requirements. We anticipate that capital expenditures for the fiscal year ending January 31, 2015 will be approximately $3.8 to $4.2 million, primarily for store and technology upgrades. We anticipate that we will be able to satisfy our short-term and long-term liquidity needs highlighted above through the next twelve months with available cash, proceeds from cash flows from operations, short-term trade credit, borrowings under our revolving credit facility (the “Revolver”) and other sources of financing. As of July 26, 2014, we have $10.5 million available to borrow under the Revolver. We consolidate our daily cash receipts into a centralized account. In accordance with the terms of our $100.0 million Revolver, on a daily basis, all collected and available funds are applied to the outstanding loan balance. We then determine our daily cash requirements and request those funds from the Revolver availability.

Our ability to improve our liquidity in future periods will depend on generating positive operating cash flow, primarily through comparable store sales increases, improved gross margin and controlling our expenses, which in turn, may be impacted by prevailing economic conditions and other financial and business factors, some of which are beyond our control, see “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended January 25, 2014 filed with the SEC on April 25, 2014.

Hancock’s cash flow related information as of the twenty-six weeks of fiscal 2014 and 2013 follows:

Twenty-six Weeks Ended

July 26,

July 27,

2014

2013

Net cash flows provided by (used in):

Operating activites

$

(8,528

)

$

(5,308

)

Investing activities

(2,351

)

(1,790

)

Financing activites

11,446

5,199

Operating Activities

Net cash from operating activities, before changes in assets and liabilities, was a loss of $0.5 million as compared to gain of $1.0 million for the twenty-six weeks of 2014 and 2013, respectively. The difference can be primarily attributed to the increase in net loss from the prior year, the non-cash charge of $379,000 for bond discount amortization in 2013, and the decline in inventory valuation of $.0.5 million in 2014 as compared to 2013.

For the twenty-six weeks of 2014, an inventory increase of $6.8 million and a $1.4 million decline in pension and SERP liabilities were the primary contributors to the $8.5 million of cash used in operating activities. For the twenty-six weeks of 2013, an inventory increase of $7.7 million and a $1.4 million decrease in pension related liabilities partially offset by accounts payable support of $4.7 million were the largest factors affecting net cash used in operating activities.

19

Investing Activities

Cash used for investing activities consists primarily of purchases of property and equipment. Capital expenditures during the twenty-six weeks of 2014 consisted primarily of store fixtures and leasehold improvements for two relocated units, one new store which opened and several other locations which will open later in the year, and development cost related to the re-launch of the Company website. Capital expenditures during the twenty-six weeks of 2013 consisted primarily of store fixtures for one new store, three relocated units, and maintenance capital expenditures for the corporate headquarters and distribution center.

Financing Activities

For the twenty-six weeks of 2014, the seasonal build up of inventory, expenditures for investing activities discussed above and the required contribution to the defined benefit pension plan produced a net increase in cash provided by financing activities of $11.4 million. During the twenty-six weeks of 2013, the seasonal build up of inventory, fixtures for four units, and the required contribution to the defined benefit pension plan, partially offset by an increase in accounts payable, produced a net increase in cash provided by financing activities of $5.2 million.

Credit Facilities

The following should be read in conjunction with Note 4 to the Consolidated Financial Statements included in this report and Note 5 to the Company’s Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended January 25, 2014 filed with the SEC on April 25, 2014.

As of July 26, 2014, the Company had outstanding borrowings under the Revolver of $67.0 million and $15.0 million under the Term Loan, and amounts available to borrow of $10.5 million.

At July 26, 2014, Hancock had commitments under the above credit facility of $1.5 million, under documentary letters of credit, which support purchase orders for merchandise. Hancock also has standby letters of credit to guarantee payment of potential insurance claims and freight charges. These letters of credit amounted to $4.9 million as of July 26, 2014.

As of July 26, 2014, the Company had an outstanding balance of $8.2 million on the New Notes.

Off-Balance Sheet Arrangements

Hancock has no off-balance sheet financing arrangements. Hancock leases its retail fabric store locations mainly under non-cancelable operating leases. Four of the Company’s store leases qualified for capital lease treatment and are reflected on the Company’s balance sheet. Future payments under the operating leases are excluded from the Company’s balance sheet.

Contractual Obligations and Commercial Commitments

Hancock has an arrangement within its Revolver that provides up to $20.0 million in letters of credit. At July 26, 2014, Hancock had commitments of $1.5 million on documentary letters of credit under the facility, which support purchase orders for merchandise. Hancock also has $4.9 million on standby letters of credit to guarantee payment of potential insurance claims and freight charges. Hancock leases its retail fabric store locations under operating leases expiring at various dates through 2025.

The Company has no standby repurchase obligations or guarantees of other entities' debt.

For further information on our contractual obligations, please refer to Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Contractual Obligations and Commercial Commitments” as presented in our Annual Report on Form 10-K for the fiscal year ended January 25, 2014.

20

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to adopt accounting policies and make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are alternative policies or estimation techniques that could be used. We maintain a process to review the application of our accounting policies and to evaluate the appropriateness of the many estimates that are required to prepare the financial statements of a large corporation. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information. There have been no significant changes to our accounting policies and estimates as discussed under Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the fiscal year ended January 25, 2014.

Related Party Transactions

See Note 14 to the Company’s Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 25, 2014 filed with the SEC on April 25, 2014, for details regarding the related party transactions that the Company has entered into.

On July 24, 2014, Neil Subin, a director of Hancock Fabrics, Inc., acquired warrants for 600,000 shares issued on November 20, 2012 at an exercise price per share of $0.59 for which he declared indirect ownership. The 600,000 warrant shares acquired by Mr. Subin were sold by Lenado Partners, Series A of Lenado Capital Partners, L.P., a member of a group owning more than 5% of our common stock.

On that same date, Mr. Subin acquired $4.2 million of our Floating Rate Series A Secured Notes Due 2017 from Lenado Capital Partners, L.P., SPV Quatro, LLC and SPV UNO, LLC., members of a group owning more than 5% of our common stock.

The Company has no other balances with related parties, nor has it had any other material transactions with related parties during the twenty-six week period ended July 26, 2014.

Effects of Inflation

Inflation in labor and occupancy costs could significantly affect Hancock's operations. Many of Hancock's employees are paid hourly rates related to federal and state minimum wage requirements; accordingly, any increases in those requirements will affect Hancock. In addition, payroll taxes, employee benefits, and other employee costs continue to increase, and the full impact of the recently enacted health care reform legislation will not be known for several years. Health insurance costs, in particular, continue to rise at a high rate in the United States each year, and higher employer contributions to Hancock’s pension plan could be necessary if investment returns are weak. Costs of leases for new store locations and renewal costs of older leases continue to increase. Hancock believes the practice of maintaining adequate operating margins through a combination of price adjustments and cost controls, careful evaluation of occupancy needs, and efficient purchasing practices are the most effective tools for coping with increased costs and expenses.

21

Seasonality

Hancock's business is seasonal. Peak sales periods occur during the fall and early spring weeks, while the lowest sales periods occur during the summer. Working capital requirements needed to finance our operations fluctuate during the year and reach their highest levels during the second and third fiscal quarters as we increase our inventory in preparation for our peak selling season during the fourth quarter.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Hancock did not hold derivative financial or commodity instruments at July 26, 2014.

Interest Rate Risk

We are exposed to financial market risks, including changes in interest rates. At our option, all loans under the Revolver and the Term Loan bear interest at either (a) a floating interest rate plus the applicable margins or (b) absent a default, a fixed interest rate for periods of one, two or three months equal to the reserve adjusted London Interbank Offered Rate, or LIBOR, plus the applicable margins. As of July 26, 2014, we had borrowings outstanding of approximately $67.0 million under the Revolver and $15.0 million under the Term Loan. If interest rates increased 100 basis points, our annual interest expense would increase approximately $820,000, assuming borrowings under the Revolver and Term Loan as existed at July 26, 2014.

In addition to the Revolver and Term Loan, as of July 26, 2014 the Company has outstanding New Notes for $8.2 million on which interest is payable quarterly on the anniversary of the issuance date of November 20, 2012. The quarterly interest is payable at LIBOR plus 12.0% on the New Notes. If interest rates increased 100 basis points, our annual interest expense would increase $82,000, assuming borrowings under the New Notes as existed at July 26, 2014.

Foreign Currency Risk

All of the Company’s business is transacted in U.S. dollars and, accordingly, devaluation of the dollar against other currencies can increase product costs although this did not significantly impact the twenty-six week period ended July 26, 2014. As of July 26, 2014, the Company had no financial instruments outstanding that were sensitive to changes in foreign currency exchange rates.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including our President and Chief Executive Officer (principal executive officer) and Executive Vice President and Chief Financial Officer (principal financial officer), as appropriate, to allow timely decisions regarding the required disclosures.

In connection with the preparation of this Quarterly Report on Form 10-Q as of July 26, 2014, the Company’s management, under the supervision and with the participation of the Company’s President and Chief Executive Officer and Executive Vice President and Chief Financial Officer, performed an evaluation of the effectiveness of our disclosure controls and procedures (as such term is defined in the Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon this evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of July 26, 2014.

22

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) within the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

“Item 3. Legal Proceedings” of our Form 10-K for the fiscal year ended January 25, 2014 includes a discussion of other legal proceedings. There have been no material changes from the legal proceedings described in our Form 10-K.

ITEM 1A. RISK FACTORS

The risk factors listed in Part I “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 25, 2014, should be considered with the information provided elsewhere in this Quarterly Report on Form 10-Q, which could materially adversely affect the Company’s business, financial condition or results of operations. There are no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended January 25, 2014

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

In June of 2000 the Board of Directors authorized the repurchase of up to 2,000,000 shares of the Company’s Common Stock from time to time when warranted by market conditions. There have been 1,756,755 shares purchased under this authorization through July 26, 2014, and the number of shares that may yet be purchased under this authorization is 243,245. The Company did not repurchase any shares in the market during the period covered by this Quarterly Report, but did accept shares in settlement of tax withholding obligations on restricted shares.

The Company did not sell any unregistered equity securities during the period covered by this Quarterly Report.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not Applicable

23

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

3.1

Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on July 31, 2008)

3.2

Amended and Restated By-Laws (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on June 8, 2012)

31.1

Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) Under The Securities Exchange Act of 1934

31.2

Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) Under The Securities Exchange Act of 1934

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